The Real Deficit Outlook

Volume IX, Number 6
October 1, 2003

At a joint press conference held on Monday, the
Concord Coalition, the Center for Economic Development, and the Center on Budget
and Policy Priorities joined forces to urge leaders to put aside partisan
differences and take decisive action to rein in the federal deficit.Â

In a joint statement, the
three groups warned that the budget outlook is much worse than the official CBO
baseline indicates.Â According to an alternate projection released at the press
conference, the budget will remain mired in deficit throughout the next ten
years, rather than return to surplus as it does in the CBO baseline.Â
Thereafter, as Boomers retire and cash in their entitlement claims, the deficit
will explode to 6 percent of GDP by 2020, 12 percent by 2030, and an
economy-shattering 21 percent by 2040.

Many Americans will assume
that the alternate projection must be based on pessimistic assumptions.Â But
this is not the case.Â In fact, even the alternate projection may understate the
gravity of the deficit problem--and the damage that current budget policy is
inflicting on future generations.

A More Realistic Scenario

Let's start with the near
term.Â According to the alternate projection, the federal budget will run a
deficit of $5.0 trillion over the next ten years.Â Like most independent
projections, this one is considerably higher than the CBO baseline, which puts
the ten-year deficit at $1.4 trillion.

Both projections are based on
an identical economic scenario in which employment and productivity grow rapidly
as the nation recovers from recession.Â The difference lies in the policy
assumptions.Â The CBO baseline assumes that the future will unfold precisely as
current law dictates.Â The alternate projection factors in a number of likely
legislative changes.Â Its purpose is to reflect the intent and direction of
today's budget policies, rather than the letter of the law.

On the tax side, the alternate
projection ignores the â€œsunsetâ€ gimmicks included in the administration's recent
tax cuts and assumes that all expiring provisions will be extended.Â It also
takes into account the cost of fixing the Alternative Minimum Tax, which would
otherwise push a sharply rising share of middle-class families into tax brackets
intended for the affluent.Â Â On the spending side, the alternate projection
includes a $400 billion prescription drug benefit, the level provided for in
this year's budget resolution.Â Â It also assumes that the administration's
multi-year defense plan will be fully funded.Â

This is a more realistic
scenario than the official baseline, but it is hardly a worst-case scenario.Â
Although the alternate projection assumes that recent tax cuts will be extended,
it allows for no new cuts in taxes beneath current levels.Â And although it
assumes that defense spending will rise to meet tomorrow's challenges, it allows
for no comparable rise in domestic discretionary spending. With homeland
security needs bulking large, this may be wishful thinking.

Vicious Dynamic

If today's deficits were a
strictly temporary phenomenon, they would be less worrisome.Â Â But in fact, the
deficit outlook rapidly deteriorates just beyond the official ten-year budget
horizon.

The reason, of course, is the
looming expense of caring for an aging population.Â Over the next decade, the
current-law cost of Social Security, Medicare, and Medicaid is due to grow by a
little over 1 percent of GDP.Â But from 2013 on, the cost will be growing by 1
percent of GDP every three and one-half years.Â All told, spending on the three
programs will rise from 8.5 percent of GDP today to 14.9 percent in 2030 and
18.4 percent in 2050--and that's without a drug benefit.

How big will the deficit
impact be?Â To answer the question, the Concord Coalition and its co-hosts
extended their near-term projections using the same kind of model the GAO uses.Â
The results are sobering: The deficit, which is projected to hover between 3 and
4 percent of GDP over the next decade, suddenly begins to rise in 2014, hitting
double digits by the mid-2020s.Â The public debt explodes in tandem--to 100
percent of GDP by the late 2020s, 200 percent by the late 2030s, and an
impossible 400 percent by the late 2040s.Â The peacetime record among modern
industrial nations is about 150 percent of GDP.

The accompanying figures
depict the vicious dynamic that generates these projections: rising federal
expenditures, which increases the deficit, which increases the debt, which
increases interest costs, which pushes up expenditures even further.Â

Daunting as the projections are, the problem could be much bigger--and arrive
much sooner.Â For one thing, the model makes the simplifying assumption that
there will be no economic feedback between deficits and interest rates, which
remain the same whether the federal government is borrowing 1 percent of GDP or
10 percent.Â As a practical matter, this is implausible.Â Â There isn't enough
U.S. savings to finance deficits approaching this magnitude without pushing
interest rates into the stratosphere.Â As for foreign savings, the United States
is already running unprecedented current account deficits.Â Moreover, most other
developed nations will be aging more rapidly than America.Â Over the next few
decades, many will be in steep demographic decline, experiencing zero GDP
growth, and struggling to finance a tidal wave of pension and health-care
outlays.Â In short, our habit of borrowing from abroad will be cut short by the
overseas age wave.

The model also allows for very
little feedback between deteriorating economic performance and the magnitude of
the federal budget burden.Â In the model, most federal spending is assumed to
grow at the same rate as GDP, no matter how slowly GDP grows.Â Yet inÂ the real
world, the dollar cost of much of federal spending is fixed.Â Medicare has to
pay for CAT scans and heart bypasses.Â The Pentagon has to buy carriers and
humvees.Â Every federal agency has to pay for salaries.Â As economic growth
slows, these costs can be expected to rise relative to GDP.Â Indeed, this is
what always happens during a recession.

Shortchanging Our Children

The bottom line is stark.Â
Unless we change course, widening federal deficits will soon be starving the
economy of investable savings and shortchanging our children.Â The problem with
deficits is that they soak up national savings and crowd out productive
investment.Â Since America's savings pool is shallow, the impact of large
deficits is especially harmful. The U.S. net national savings rate is already
low both relative to other developed nations and to our own history.Â Current
fiscal policies are due to push net national savings still lower, ultimately
driving it beneath zero.

This brings us to history's
bottom line, as insisted on by one economic luminary after another, from Adam
Smith to Karl Marx to Alfred Marshall to John Maynard Keynes: No country can
enjoy sustained living standard growth without investing, and no country can
sustain high investment for long without saving.

Â Â Â
The long-term projections show that current federalÂ budget policies are
unsustainable.Â Let's hope that we don't have to suffer a fiscal and economic
crack up before changing direction.Â The time to act is now, while people still
have time to adjust and prepare--not ten years from now, when the trade-offs will
be all the more painful.Â This is the last decade before the age wave rolls over
the budget.Â Let's make sure it's not a lost decade.â–